In trading, we all know there are a lot of variables. One huge forex variable is the trend. Almost every trader wants to recognize the trend, whether they are going to trade with it or against it, but it begs the question: What is the trend? We determine this through trend analysis.
How do we determine which way the market is trending? For a trader who scalps on the five-minute forex charts, is the trend found on the 15-minute chart? That may be the trend he is looking at, but what if the 4HR is very strong in the opposite direction?
How to do Trend Analysis
Let’s look at a trend analysis example:
These are past charts of the USD/JPY. Which one is actually the trend?
This makes trading interesting. Things become very relative and subjective based on what and how you are looking at things.
A swing trader may say that the Daily chart (on the left) is obviously the true trend, but an Intra-day trader could very well assume that the 30Minute chart (on the right) is the best indication of the trend. Again, it is totally relative to what they are looking at.
However, I think that we do need to be able to establish some objective truths about what is going on in the market. If we just have the mindset that everything is relative in trading then we can’t have any confidence or expectation in our trading. Without some objective reasoning that certain things are going on, how could we be confident enough to put our hard-earned money on the line?
Here is what I propose as a solution to this situation:
We determine the trend, OBJECTIVELY in these three-time segments: Long-term, Mid-term, and Short-term.
Long-term: Monthly and Weekly
Mid-Term: Daily, 4HR, and 1Hr
Short-Term: 15Minute, 5 Minute, 1 Minute
Establishing the trend on these three-time segments can help with your overall approach to a trade setup. It should allow you to enter a trade with some more confidence knowing that you have a larger view of what is going on with the specific currency pair you are trading.
This idea should be something that you can implement into almost any Trading plan or strategy. It is very simple but very effective.
I actually thought that this idea of using multiple time frame analysis techniques was very original, but apparently, I am not the first to think of it 😛 (DailyFx has a great article on Multiple TimeFrame Analysis where he uses the same terms for the 3-time segments)
Now, if you are a trend trader, you can use this idea as a filter for your trades.
In short, you can decide that a filter for your entries is confluence among the three-time segments. In other words, in order for you to take an entry, you need the trend to be the same in the long-term, mid-term, and short-term time segments.
So, if you see a nice hourly sell set up, you check your three-time segments. If they look like this:
Then you would not take that set up because all of the time frames do not support you.
If you see a strong 15 minute buy signal and your three-time segments look like this:
Then you would be okay to take the trade because all time frames agree with you.
Now, one may ask why the Monthly and Weekly charts need to agree with you if you are taking a 15-minute signal, and there is definitely validity to that, but I DO want them to agree with me. For one, it is just about total momentum. When you have the larger time frames trending your way, that is significant momentum. The other reason I like the larger time frames to agree with me is that I often use a strategy where I add to a position that goes against me if I think it is going to turn back around. With the larger time frames still trending in the original direction of my entry, I have much more confidence that the trade will re-route into that direction at some point.
Now, I am certainly not saying that every trade that agrees with all three-time segments is eventually going to go back into that direction if it doesn’t work out on the first entry, but I do think this is a great way to filter your trades and make them more precise.
As always, let us know what you think. Have you mastered using a miltiple time frame analysis?